Unethical Insider Trading
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Contents
Unethical aspects of insider trading. 2
Moral issues in insider trading. 5
Introduction
Insider trading is profitable trading in securities that is done through access to confidential information. When investors hear of the term ‘insider trading’, they associate it with illegal conduct, even though the term has both legal and illegal elements. The legal version takes the form of a situation whereby corporate insiders such as directors, officers and employees engage in buying and selling of stock in their individual companies. Every time corporate insiders start trading in their own securities, the law requires them to report each trade to the SEC.
Unethical aspects of insider trading
Illegal insider trading takes place when a security is bought or sold in complete breach of a fiduciary duty or any other relationship of confidence and trust, whereby the buyer or seller is in possession of nonpublic material information about the security. Insider trading violations can also take the form of ‘tipping’ such information or trading in the securities using the ‘tipped’ material information. It is also illegal for people who have misappropriated such information to use it to engage in any securities trading.
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Some directors, corporate officers and employees choose to trade in a company’s securities after acquiring significant, confidential developments within the corporation. Such activities are generally considered illegal, immoral and unethical (Moore, 2004). Some individuals even go further to ‘tip’ business associates, friends and family members. If such parties deal in the securities after acquiring such information, they are also considered to have acted illegally.
Insider trading is also common among employees of brokerage, banking, law and printing firms, who obtain confidential information while rendering services to the corporation. Government employees may also learn of such confidential information because of their position of employment by the government. Another scenario whereby illegal insider trading is possible is where other persons misappropriate and take advantage of confidential information about their corporate employers.
Insider trading profoundly undermines investor confidence in the integrity and fairness of security markets (Ma & Sun, 1998). This is why many security market managers prioritize matters of detection and prosecution procedures for insider trading violations. The US Securities Exchange Commission (SEC) for example, has adopted new rules aimed at resolving issues where disagreements have been made in courts.
The first rule (10b5-1) provides for instances when a securities trader is presumed to be ‘aware’ of any material nonpublic information whenever he is buying and selling securities (Martin & Peterson, 2001). The second rule (10b5-2) provides a clarification on the application of the misappropriation theory in non-business relationships. According to this rule, any person who receives confidential information under any of the conditions specified in the rule owes a duty of confidence and trust to the corporation. Therefore, he could be liable for a breach of confidence and trust under the misappropriation theory.
The case of Martha Stewart
Martha Stewart was a shareholder at a company known as Imclone. In 2001, she was involved in high profile insider trading cases that caught the attention of media and academic professionals. As a result, a lot of research and writing efforts went into the case, particularly with regard to moral, ethical and legal issues that arose out of it (Rawls, 2009).
In 2001, Imclone received a notification that the new prescription drug, which the company had spent a lot of money on through research and development, was not going to get the approval of the Food and Drug Administration. The company’s CEO, in frantic efforts to prevent financial losses to his shares at Imclone, called his stockbroker and instructed him to sell all his shares that were part of the company stock. The broker was also serving as a broker to Martha Stewart, and he informed her about the CEO’s decision. He advised Stewart to follow suit since it was in her best interest to sell the shares that she held at the company stock, totaling almost 4000 shares. The SEC noted that there was an unusual activity since the CEO had sold his shares. The SEC launched investigations in order to find out whether Martha Stewart was involved in insider trading.
Researchers and academicians point out to the fascinating legal technicality which presents itself through the fact that Stewart could not necessarily be said to have breached any fiduciary duty to any other investor since it was not her responsibility to inform any of them. This would be the case only if she was an employee of the company. Therefore, it is possible that if Stewart had confessed to all her activities initially, she may not have been found guilty of insider trading. However, Stewart did not take that course. Instead, she collided with her broker to try and fabricate a story about an existing standing order, whereby Ms. Stewart would sell all her shares immediately the stock price dropped below $60 per share.
The main ethical issue that arises out of Stewart’s case entails the question of whether she knowingly engaged in illegal behavior. It appears that the answer to this question is no. In this regard, discussions might arise on whether insider trading ought to be unethical or it should be illegal. However, it is clear that Ms. Stewart knowingly engaged in an unethical act when she conspired with her broker in order to defraud the SEC to this extent, no claim to ignorance can be considered credible.
Apart from facing charges for engaging in ImClone-related fraud, Ms. Stewart was also accused by investors from Martha Stewart Living Omnimedia Inc., a company that she owned. These investors alleged that she sold many of her shares within the company in efforts to avoid further financial liabilities. Additionally, she faced accusations of manipulating her own company’s stock through the expression of innocence to all the charges. This last charge was later on dropped. Later on, Stewart was found guilty of insider trading and was handed a fine and a jail term.
Moral issues in insider trading
Although the SEC has already spelled out all the activities that define insider trading through specific definitions and laws, many moral laws tend to be violated by insider trading (Dooley, 1980). The main aspect of legality in insider trading involves the executive’s fiduciary responsibility to all the company’s investors. However, the puzzling question is on whether or not the executive is morally obliged to share with the shareholders any information that may negatively impact on their stocks. In answering this moral question, the relationship between the shareholders and the executive should be examined.
The executive is arguably an employee of the shareholders. This is because shareholders are a section of the company’s owners. The underlying reason why any shareholder sells or buys stock is to avoid losses and to make profits. When shareholders invest their money in the company, they have hope that the executive will run the company well and make decisions that will facilitate the generation of maximum profits. Profits lead to an increase in the value of the company’s shares.
On the issue of Stewart’s scenario, the information regarding the FDA’s refusal to approve the medication did not involve the executive’s decision. Nonetheless, it was potentially going to bring about the loss of the shareholders’ money. Although ImClone’s CEO sold a large chunk of his share in efforts to avoid financial loss, the unresolved question is whether this sale had an effect on the value of the stock held by other shareholders in the company. One may argue that the purchasers of these shares that the CEO sold were the greatest sufferers of insider trading. However, there were buyers of these stocks anyway, whether the seller was the CEO or some other shareholder. For this reason, there was no direct relationship between the lower stock price and insider trading.
Although insider trading can reduce the amount of loss incurred by the insider, this does not seem to happen at the expense of another shareholder. If this is the case, and there is a fraud or crime of theft committed, who is the victim? It appears there is no individual who is plunged into a worse financial position resulting directly from insider trading.
Conclusion
In conclusion, insider trading is legally and ethically wrong but morally, maybe not. If the insider or executive shared patented or trademarked information, he would have been guilty of a violation of a confidentiality agreement with ImClone. However, the true ethical violation is not about the selling of stock, but the use of the company’s confidential information for purposes that are outside of the company’s context, that is, for avoiding personal financial losses. Although the use of company information for personal gain, it sounds quite awful, it is difficult to point out anything that is morally wrong in it. After all, real-life business scenarios are full of examples whereby people benefit personally because of having the advantage of possessing certain information and choosing not to disclose it to everyone.
References
Dooley, M. (1980) Enforcement of Insider Trading Restrictions, Virginia Law Review, 66(1), 1-83.
Ma, Y. & Sun, H. (1998) Where Should the Line Be Drawn on Insider Trading Ethics? Journal of Business Ethics, 17(1), 67-75.
Martin, D. & Peterson, J. (2001) Insider trading revisited Journal of Business Ethics10(1), 57-61.
Moore, J. (2004) What is really unethical about insider trading? Journal of Business Ethics9(3), 171-182.
Rawls, K. (2009) Martha Stewart and Insider Trading, Retrieved from http://digitalcommons.liberty.edu/busi fac pubs/3, on September 13, 2010.
